On July 31, 2008, Geoffrey Arbuthnott drove from his home in Hertfordshire to an upmarket restaurant at The Hoste Arms in the small town of Burnham Market in Norfolk. He arrived early and waited in his car for his former colleague Edward Cox, chairman of the legendarily low-profile Charterhouse Capital Partners, to arrive.

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Arbuthnott had worked at the firm for over 20 years and had retired earlier that year but still held 8.9% of the shares in Charterhouse Capital Limited.

Fast-forward six years and what was said at that lunch at The Hoste Arms, a pub that claims a history dating back to 1550, is now being raked over by about a dozen lawyers the Chancery Division of the High Court in London as part of a six-week trial that centres on a disagreement over the value of Arbuthnott’s shares in the firm.

Alleged blackmail is just one of a number of issues that have come out in court but the real heart of the case is how private equity firms deal with succession and find a fair price to pay old guard partners for their shares once they retire.

The case has also provided a rare insight into the workings of Charterhouse. Despite an 80-year history, outsiders know relatively little about the inner workings of the group, even though it controls more than €8 billion of investments, because it is run by a small, tightly knit group of long-time executives.

Arbuthnott has launched legal action against Charterhouse and current and former colleagues, saying that the firm’s executive chairman Gordon Bonnyman and 15 other current and former Charterhouse shareholders tried to force him to sell his entire stake in the firm in November 2011 for £1.35 million – which he says is less than its true value. He is now petitioning the courts to get an independent valuation of the shares.

Bonnyman’s lawyers, Slaughter and May, described the proposed purchase price of the shares as fair in court documents and said that Arbuthnott was pressuring the respondents to buy his shares at a “grossly inflated price”.

Although both sides say the lunch took place, the tone and what was said are in dispute. Cox said in a witness statement that the meeting was “frosty” but speaking in court last week Arbuthnott said it was “difficult but amicable” and “businesslike”.

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Lawyers for Charterhouse now state in court documents that over the two-course, hour-long lunch Arbuthnott tried to blackmail the firm by alleging malpractice during the buyout in 2005 of washroom service provider PHS.

The lawyers say that Arbuthnott said the then-UK regulator the Financial Services Authority would “go nuts” if it knew the details of the matter and said: “Buy my shares and I go away”. Charterhouse strongly denies any malpractice.

At the end of the lunch, which Cox said he paid for, Arbuthnott said that he wanted £50 million for his shares and 9% of the carried interest in the firm’s ninth fund, according to Arbuthnott in court last week. Carried interest is a share of the fund’s profits which can be retained by the fund’s managers and which in Arbuthnott’s case could be worth additional tens of millions of pounds.

Arbuthnott said in witness statements that he had “no intention of blackmailing anyone” and felt that he was raising legitimate business concerns.

Lawyers for Charterhouse said in court documents: “The ‘concerns’ were merely ammunition to try and force a purchase price higher than Charterhouse or its other members would be willing to contemplate”. The documents added: “The language he used was plainly an unjustified threat made to make an illegitimate gain unless his demands were met.”

Background and history

Arbuthnott had worked at Charterhouse for 20 years before retiring several months before the meeting in Norfolk in 2008. He described himself in court last week as Bonnyman’s “right-hand man”, who met with the top director for around an hour every morning to discuss the business.

Bonnyman, widely credited as being the driving force behind Charterhouse’s rise to prominence, was formerly managing partner of Charterhouse but stepped back from running the firm and became executive chairman in 2012.

During the 1990s, Arbuthnott was one of the most important investment managers at the firm and responsible for some of the most significant transactions, including the very profitable investment in train owner Porterbrook Leasing in 1996.

Charterhouse was spun out from HSBC in a management buyout in 2001, with executives paying £6.1 million to take control of the business. At the time of the buyout, Bonnyman was the largest shareholder with 17.8% of the shares, followed by Arbuthnott who held 8.9% of the shares and seven other partners each taking around a 7% share in the business, according to court documents filed by Charterhouse.

Soon after the spin-out, fundraising began in earnest, with the firm raising €2.7 billion for its seventh fund, which closed in 2003. That fund delivered handsome returns for the firm’s executives, paying out carried interest of over £353 million for Charterhouse’s executives between August 2007 and October 2010, according to Arbuthnott’s lawyers in court documents, which has never previously been disclosed.

Overall, the firm’s funds from its fourth fund (raised in the late 1980s) to its eighth (raised in 2006) generated average returns of 2.8-times the original investment, according to Arbuthnott in court last week.

In the years leading up to his retirement, Charterhouse had made Arbuthnott a wealthy man. He was paid around a total of £49.2 million in salary, bonus, pension contributions and carry from 2002 to 2006, according to court documents filed by Charterhouse.

But Arbuthnott’s retirement from the firm had been a different story, with his share of entitlement to the carried interest in the firm’s eighth fund cut by Bonnyman in a meeting in his office in 2006, according to documents from both sets of lawyers.

Commenting on the meeting on the eighth fund, Arbuthnott said in court last week: “I said ‘I’m just getting mugged here’. I had been there 20 years and had great performance appraisals and then this. I didn’t see this coming. There was no warning.”

Documents filed by Bonnyman’s lawyers justified the cut in Arbuthnott’s carry by saying that Arbuthnott had become increasingly “disengaged” from the running of Charterhouse, had not wanted junior members of the business to buy shares in the firm and had last worked on a deal in 1999. Arbuthnott said in court that he was closely involved in the running of the business, was effectively Bonnyman’s deputy and was particularly involved in fundraising for the firm’s seventh and eighth funds.

Arbuthnott had also seen his bonuses steadily decline in the years leading up to his retirement, from £2 million in 2003 to £400,000 in 2007, according to court documents filed by Charterhouse.

“By December 2007, it was pretty clear that Bonnyman wanted me out”, said Arbuthnott in court last week.

In January 2008, Arbuthnott had handed in his retirement notice, but still held on to 8.9% of the shares in the firm and was keen to have his portion bought out.

The blackmail allegations

By mid-2008, when Cox and Arbuthnott met at The Hoste Arms, little had been resolved and the meeting only served to make relations even more strained between Arbuthnott and the firm.

The most serious allegation that Arbuthnott has made on misconduct relates to PHS, as it was a listed company. Charterhouse bought the company for £215 million in 1999, then floated it in 2001, valuing the company at £414 million. In 2005, PHS put itself up for sale, and according to documents for Charterhouse, Charterhouse investment manager James Arnell and fellow Charterhouse executive Stuart Simpson had a meeting in 2005 with Peter Cohen, then chief executive of PHS, just before final bids for PHS were to be submitted.

Arbuthnott’s allegations about wrongdoing in the PHS bid have not been made clear in court. However, Charterhouse’s lawyers say in court documents that Arbuthnott alleged Simpson might somehow at that meeting have learnt the PHS board’s “walk away” price – information that would be very useful in the auction if known.

Arnell told Charterhouse’s lawyers in court documents that Cohen did not disclose any information concerning a “walk away” price. A spokesman for Cohen told Financial News that he “firmly denies any wrongdoing” and said “no inappropriate conversations took place between himself and Mr Simpson”.
The spokesman added: “In accordance with proper practice, all discussions regarding the Charterhouse Capital offer were conducted by the independent non-executive directors of the PHS board, and not the executive directors”. A spokesman for PHS declined to comment.

Charterhouse documents filed with the court say no price was disclosed and that anyhow Charterhouse “was not at the time focused on pricing any bid”.

In July 2005, Charterhouse bought PHS for £730 million in debt and equity, according to Charterhouse’s website.

Court documents for Charterhouse added that it commissioned law firm Dickson Minto to investigate allegations of improper business practice.

The report found that “there had been a number of relatively minor breaches of process letters and confidentiality agreements” but there had “been no significant breach of any FSA rules or principles and that no FSA notification was required” – in other words, there was no need to tell the then-regulator Financial Services Authority of any rules broken.

The FSA’s successor, the Financial Conduct Authority, declined to comment.

Watling Street

After the lunch in Norfolk, a series of letters went back and forth between Charterhouse’s lawyers and Arbuthnott’s lawyers but the parties were still in deadlock by January 2011. By then, several of the founding partners of the firm had retired, while some others were close to retirement. Bonnyman was stepping back from the running of the firm.

It meant that over half of the shares in the business were owned by retired or soon-to-be-retired partners, with younger people on the investment team unable to get a slice of ownership. Bonnyman agreed that it was time to devise a solution to the firm’s “misalignment” problem, as it would be a worry to investors and was disincentivising junior investment managers. He appointed Dickson Minto to come up with an answer, according to Charterhouse’s court filings.

Dubbed “Project Parker” by Charterhouse’s general counsel Tom Patrick, the law firm proposed creating a new structure, called Watling Street Limited, referring to a narrow street near London’s St Paul’s Cathedral, that would buy out the existing shareholders for a total of £15.15 million. This valued Arbuthnott’s stake at around £1.35 million, according to court documents from Arbuthnott’s lawyers.

Charterhouse executives paid a nominal £200 to become members of Watling Street Limited. Subject to a few provisions, when Charterhouse executives retire they will be forced to give up their interest in the vehicle and will be paid back their initial £200, according to court documents from Charterhouse and a firm spokesman, meaning Charterhouse would no longer have non-active staff as shareholders.
By November 2011, Watling Street made offers to all the Charterhouse shareholders. All accepted except Arbuthnott.

Arbuthnott said that he was not provided with adequate information on why the new vehicle was set up and that the price he was being offered was too low, according to documents filed by his lawyers. In court he said that valuing Charterhouse at £15.15 million was too low, “absurd”, and that “I have always said that all I wanted was an independent valuation” of the shares.

Private equity firms are hard to value. Experts called by Arbuthnott have given figures ranging from £20 million to £325 million. Charterhouse’s own experts KPMG valued the business at between £10 million and £20 million in 2009.

The case continues, with about five more weeks of hearings expected.

• Allegations over private jet expenses

When Charterhouse’s then-chairman Edward Cox met Geoffrey Arbuthnott for lunch at The Hoste Arms in 2008, Arbuthnott made a series of allegations. Among them: $23,000 in private jet expenses had in effect been paid by investors in Charterhouse’s funds when they should have been paid by Charterhouse itself, according to a court witness statement from Cox.

Both Arbuthnott and Gordon Bonnyman had been using a private plane to travel across America visiting potential investors for Charterhouse’s fundraising around January 2006, according to the statement.

Flights

The statement says Arbuthnott said at the lunch that Bonnyman used the private jet to travel from Albany to Fort Lauderdale in Florida for personal reasons in January 2006. Cox noted that Arbuthnott said this “$23k” flight was later charged to “fund expenses”.

In the private equity industry, travel, salary costs and other overheads are usually paid for out of the firm’s own expenses, rather than from investor money.

Probe

After the lunch, Cox says that he asked Charterhouse’s former compliance officer Thomas Plant and former director Roger Pilgrim to investigate the matter.

In his witness statement Cox says that Pilgrim found the expenses should “perhaps properly have been billed to the firm rather than the fund” but that “it was a relatively immaterial expense in relation to the size of the fund and the expenses which were incurred by Mr Bonnyman and other members of the team in conducting the fundraising”.

Cox’s witness statement added that Pilgrim found that this incident wasn’t “representative of a culture at Charterhouse of excessive expenses or of a ‘free and easy, high spending (of other people’s money) approach’ at the firm”.

A spokesman for Charterhouse said: “This was a legitimate expense relating to a lengthy fundraising trip in the United States.

“The tardy allegation should be seen in the context in which it was made. It was accompanied by an offer to ‘go away’ if Mr Arbuthnott’s shares were bought for a ludicrous price.”

The spokesman added that Bonnyman couldn’t comment as he is giving evidence in the ongoing court proceedings.

• Who runs Charterhouse?

In 2009, after the firm’s ninth fund was raised, long-standing managing partner Gordon Bonnyman (right) began sharing his management responsibilities with Lionel Giacomotto, Malcolm Offord and Jeremy Greenhalgh, according to documents filed by Charterhouse. This governance structure was deemed too “cumbersome” by the investment team, with matters coming to a head in 2011. At the end of 2010, the firm had a larger-than-normal bonus pool. Instead of dividing up the excess cash among all the members of the investment team, the four-person management team decided to keep the extra bonus money for themselves, according to documents filed by Charterhouse.

This prompted a “backlash” from the investment team, with two directors tendering their resignations, the documents state. After internal discussions, a consensus emerged that Giacomotto alone should succeed Bonnyman as managing partner and that in the future bonuses would be divided up as in previous years. In the end, both directors withdrew their resignations, according to documents filed by Charterhouse.

At present, Bonnyman and Giacomotto jointly guide the important decisions at the firm, particularly on identifying early-stage prospective investments and setting remuneration, according to documents filed by Charterhouse.

Certain decisions are then formally put to Charterhouse’s various committees. At the top of the pile is the executive committee that has responsibility for the day-to-day running of the business, including financial reporting, tax and compliance. The remuneration and allocation committees respectively set bonuses and carried interest levels for investment directors. The board investment committee, on which all income members of the firm sit, then makes the decisions about what businesses Charterhouse will buy or sell and at what price. All other issues are discussed at quarterly limited partner meetings.

--This article was first published in the print edition of Financial News dated February 3, 2014